To what extent can increased sale of government bonds fund the shortfall in revenue of relief associated with the Covid-19 epidemic?

12 May 2020

THIS BRIEF EXPLORES THE POSSIBILITY OF ALLOCATING TO BUYERS THE FULL AMOUNT OF SHORT-TERM, LOWER-YIELDING GOVERNMENT BONDS FOR WHICH THEY BID, THE IMPACT ON THE AVERAGE YIELD TO MATURITY, AND HOW THE AVAILABILITY OF THIS FUNDING OPTION VARIES WITH CIRCUMSTANCES.

INTRODUCTION

Before a national disaster and lockdowns were declared in South Africa the fiscus was already in poor shape. Nonetheless, to try and ease the effects of lockdown the government has announced R500 billion in additional spending. This amounts to 10% of GDP, comparable to what the US has spent on its relief efforts. The stimulus has been more than 30% of GDP in both Italy and Germany.

When reporters asked South Africa’s Treasury officials if the R500 billion fund raising and distribution efforts would be enough, they were reluctant to provide details on the subject or on the wider implications for the fiscus, until an adjusted budget is announced. Whether there will be an adjusted budget in the short term, or whether a budget adjustment will be introduced with the October Medium Term Budget Policy Statement is unclear.

THE OPTIONS

With a budget deficit expected to widen to more than 10% of GDP, government will need to consider a number of proposals to help the country’s economy and its citizens. Among them are: bilateral loans from other countries, an additional loan facility from the IMF or the route the apartheid government took of prescribed assets. It is doubtful that any or all of these will be of the scale required to finance the government continuously for the next 12 months. The main source of funding is likely still to be weekly bond auctions.[1]

INCREASED FUNDING FROM A FULL ALLOCATION OF TREASURY BONDS AND BILLS AT WEEKLY AUCTIONS

Using the available information from the South African Reserve Bank’s bond and bill auctions during the two months preceding the lockdown, February and March, this brief is designed to answer the question: how much more funding could have been raised by a full allocation to bidders and at what interest rates?

The results of our study are shown in the tables below:

Vanilla Bonds Auctions

Inflation Linked Bond Auctions 

Treasury Bills

During February and March, all bids were fully allocated for the 91 day and 182 day Treasury Bills. This was not the case for 273 day and 365 day Bills as the table below indicates:

To calculate how much more funding could have been raised by a full allocation to bidders for short-term bonds, we subtracted the amount of bonds that were allocated at each auction from the amounts that were bid for by buyers. This gave a total of R 71.88 billion that could have been raised (R 62,145m + R 9,735m) in these auctions over February and March, an average of R 36 billion per month.

The additional R 71.88 billion, however, would have encountered higher interest rates, as shown by the ‘Premium %’ column above (New Yield % minus Weighted Average Yield %).[2] In addition, the bid/allocation ratios also change according to circumstances. As the liquidity situation became more difficult over February and March, the premium became greater and the bid/allocation ratios smaller, meaning less potential funding at a higher cost. The Reserve Bank has stated that it will intervene when there is a lack of liquidity, and this policy will render crunch periods brief.

Additional funding of R 59.94 billion (R 29,740 m + R30.200m) could have been raised from sale of longer dated Treasury bills, an average of R 30 billion per month.

These estimates are likely to be over-estimates for two reasons. The first is that greater success of bidders in one week may lead to reduced demand in the next. The second is that, were it known that most or all bids would be taken up regularly, more aggressive bidding may emerge, raising yields, possibly to an unacceptable level.

Given a sharply rising yield curve, it is markedly cheaper to raise funds from bills and short-term bonds. However, this strategy would shorten the average maturity of government debt and require more frequent rollovers. Shorter average maturity implies greater vulnerability.

CONCLUSION

The South African government will have to raise more funds to try and alleviate the effects of the COVD-19 pandemic. One of the possible sources for these funds is the domestic capital market through an increased sale of government bonds and bills.

However, unless confidence in this market is restored via much needed structural reforms to the economy generally and movements towards re-attaining investment grade ratings by the agencies, funding will be expensive, adding stress to the fiscal position.

Charles Collocott, Policy Researcher, Helen Suzman Foundation. 

[1]https://www.businesslive.co.za/bd/opinion/columnists/2020-04-20-carol-paton-thinking-on-role-of-the-state-and-reserve-bank-needs-to-be-upended/

[2]The New Yield % is the weighted average of (a) the reported average yield and the (b) average of the highest bid yield and the reported average yield.